In recent times, both employees and employers have become cognizant of the tax implications of payroll amounts and the significant impact such taxes can have on an employee's take-home pay. One particular vehicle for reducing tax burden provided for under the tax laws is the 401(k) plan. Such plans, which are offered by almost all major employers and by an increasing number of small employers, are designed to encourage retirement savings in return for deferred taxation on the income
The monies contributed to the plan are invested in one or more investment alternatives offered by the particular plan. One prominent investment alternative associated with 401(k) plans is mutual funds. Often, 401(k) plans offer investment opportunities including a particular mutual fund family with each of the particular mutual funds representing a particular investment directive. Participants are typically provided with the ability to exchange shares of one mutual fund with another. In view of the purpose for 401(k) plans (encouraging retirement savings), withdrawals (fund redemptions) prior to retirement age are severely limited and often carry an associated tax penalty.
In a typical scenario, 401(k) participants purchase and redeem shares in mutual funds through the transfer of payroll assets to a transfer agent (for a purchase) or through the transfer of fund assets to the participant (for a redemption). The transfer agent acts on behalf of the mutual fund or family of mutual funds in order to execute all transactions (including purchases, redemptions and exchanges between funds) relating to one or more funds. All such transactions are subject to various tax reporting requirements and legal and accounting restrictions.
The tax laws applicable to 401(k) plans are, at best, complex. Such constraints as maximum contributions per employee, detailed IRS reporting requirements and significant administrative responsibilities may be problematical for employers both large and small. Due to this complexity, many employers enlist the services of a record keeper. The Department of Labor's interpretation of rule 404 (c) indicates that a provider can limit their fiduciary liability if a wide variety of investment options are available within the 401(k) plan it provides and if they increase the frequency by which participants in the 401(k) plan can change their elections. This interpretation has encouraged many employers to increase the selection of investment options available within its 401(k) plan. As more and more plan sponsors enhance their plan and offer more investment options, the need for accurate record keepers to assist in the growing task of overseeing these plans increases.
Valuation of investments in retirement plans, such as a 401(k) plan, was traditionally performed using a technique called balance forward. In such a system, changes to investment options in the plan would only become effective at the end of a balancing period, for example, quarterly. The balance of the account throughout the quarter thus was brought forward to the end of the quarter for valuating the participant's account. Participants in these plans, however, began to demand daily valuation, whereby investment options could be altered on a daily basis and whereby balances for the participant's account would be updated daily. Performing daily valuation requires that the record keeper of the 401(k) plan report the market value for each participant's account on a daily basis. Any errors on the part of the record keeper may make the record keeper "financially" liable to the participant.
Unfortunately for plan participants, plan sponsors, and record keepers, there has heretofore been no ability to perform the required transactions in a timely, accurate and efficient manner and without a significant amount of human intervention which is required to meet the objective of providing daily valuation. In most cases, it is currently necessary to acquire or develop an accounting system and specialized staff working throughout the day and the night to process plan adjustments and transactions to complete valuation on a daily basis. This is a necessity because plan sponsors as well as plan participants demand timely access to current positions and recent transactions associated with the plan accounts. As a result, significant labor and equipment charges are incurred to provide the required daily accounting cycle. In addition, reconciliation of accounts is often difficult to achieve and inaccuracies are often introduced.
Also, problems exist for transferring information between the record keepers and the host processing center. Particularly, the data sent by the record keeper may be inaccurate, incomplete, or otherwise incompatible with the information needed by the host processor. Not all of the records in a file may be erroneous and it may be desirable to sort through and process the valid records and reject the invalid ones.